A Simple 401k Strategy to Help Manage Risk

Posted by clannad0901 on

A Winning 401k Strategy

 

Recently, I was speaking with a Raytheon employee about a simple 401k strategy and the investment options inside his company’s plan.  He mentioned that he only invests in the Northern Stock Index, which is an S&P 500 Index fund.  He’s been doing this for years because he feels that none of the investment options available to him can outperform the index consistently.  This is probably true, but investing only in the S&P 500 doesn’t alleviate his major concern.

 

The reality is that the market will probably experience a deep correction before his retirement.  After the -49% correction in 2000 and another -56% correction in 2008, his concern is quite legitimate.  In May, only 37% of the 100 most widely held mutual funds within 401k’s outperformed the S&P 500; eight of those that did outperform were also index-like funds.  Longer term studies suggest that my friend was correct about most funds not beating the S&P 500.

 

401(k) top performers May 2016

If you’re paying attention to any of the major financial news outlets, then you’re feeling a bit bi-polar and tend to ebb between constantly nervous and occasionally euphoric. The current rotation of topics include the BREXIT, Terrorism, or the poor US economic recovery.  Younger investors should be comforted knowing that their investment time horizon is in the distant future.  This is a luxury that most older investors do not have. 

Are there other options in your plan?

Many other investors from companies like Lockheed-Martin and Boeing have tried to ameliorate the problem by using target dated funds.  This option brings a whole new set of problems that we will discuss in a later blog post. Another option is to use the advice provided by your platform provider, such as Fidelity or Vanguard.  There is an obvious dilemma resulting from the conflict of interest of their compensation.  The two largest 401k plan providers generate revenue from internal fees and trading costs (they’re normally sending trades to their own trading desks and charging ‘themselves’ [the client] higher execution charges). With this in mind, they will never tell you to raise any significant cash levels, but rather keep you invested in those fund that generate revenue for their firm.

The Best 401k Strategy to Manage Risk

In general, investors are significantly better served by using a strategy and actively managing their own 401k’s.  This can be done by utilizing an independent newsletter service like the one we offer (or another), or at the very least applying basic risk management techniques.  Aside from a trend following strategy like ours, the next best solution is the use of a specific price “stop”.  There is no mechanism to enter stop-loss orders on mutual funds like that available in the stock market, but you can use a free third party service    The easiest is the free service offered by yahoo, which is incredibly simple to use:

  1. Browse to finance.yahoo.com
  2. Create a portfolio of your holdings (“My Portfolios”)
  3. Set Alerts ($ or %)

Mutual funds are priced at the end of the day, so the e-mail alerts you receive will be in the evening.  This will give you an opportunity to re-position your account the next morning when necessary.  If you’re selecting your funds correctly, your alerts should be few and far between, meaning fewer transactions.  You should place a “stop”(sell alert) that you’re comfortable with (maybe 9%) below your initial purchase price.  This will allow some “breathing room” for normal market volatility.  On a monthly basis, you should raise that stop/alert as the price moves up.  When the market does eventually crash again, your retirement money won’t crash with it.

 

Do you actively manage your 401(k)? Tell us about your buy and sell discipline- How do you manage risk?